We have VM environment and have sql server licens per CPU. We have all VMs in UCS. That is basically big machine with lot of power. VMs created inside UCS.

My question is:As we have license per CPU, can we install multiple instances of SQL Server on this UCS. These instances will share same CPUs. In VM environment only portion of exsiting cpus allocated to each vm server. Is there any limit or how licensing will work in this environment.

It depends on which edition of SQL Server you're using. For 2008 R2 Datacenter I believe a processor license is valid for an unlimited number of VMs. Enterprise Edition may be limited to 4 VMs but don't quote me on that.

As always, the best thing to do is contact a Microsoft rep and ask about the licensing options.